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The  Actuarial/Investment  Partnership  I

Mark  Randall November  9,  2015

Actuarial Changes and the Investment Assumption

 

The  Importance  of  the    Actuarial  Funding  Policy

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TMRS’  Actuarial  Funding  Policy

Ã The  primary  financial  objective  of  TMRS  is  to  pre-­‐‑fund  the  long-­‐‑term  costs  of  promised  benefits  to  plan  members  and  beneficiaries  at  an  approximate  level  percent  of  payroll  from  year  to  year

Ã The  Actuarial  Funding  Policy  is  the  “road  map”  for  this  objective

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TMRS’  Actuarial  Funding  Policy

Ã   The  City’s  employer  contribution  determined  annually  under  this  funding  policy  is  called  the  actuarially  determined  employer  contribution  (ADEC)  and  serves  as  the  basis  for  determining  the  Full  Retirement  Rate  contribution  under  TMRS  

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TMRS’  Actuarial  Funding  Policy

Ã The  TMRS  Act  requires  each  City  to  contribute  a  monthly  amount  equal  to  the  normal  cost  contribution  and  prior  service  contribution

Ã This  is  the  ADEC

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TMRS’  Actuarial  Funding  Policy Ã   Normal  cost  contribution  rate  and  prior  service  cost  contribution  rate  are  determined  by  the  following  three  key  components: 1.  Actuarial  Cost  Method 2.  Asset  Smoothing  Method 3.  Amortization  Policy  

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Actuarial  Cost  Method

Ã The  technique  used  to  allocate  the  total  present  value  of  future  benefits  over  an  employee’s  working  career

Ã TMRS  uses  the  Entry  Age  Normal  (EAN)  actuarial  cost  method u By  far,  the  most  commonly  utilized  method  in  the  public  sector

u Now  required  for  GASB  (pension  accounting)  disclosures

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Asset  Smoothing  Method Ã The  technique  used  to  recognize  gains  or  losses  in  pension  assets  over  some  period  of  time  so  as  to  reduce  the  effects  of  market  volatility  and  stabilize  contributions  

Ã Actuarial  Value  of  Assets  (AVA)  is  based  upon  the  Market  Value  of  Assets  (MVA)  with  ten-­‐‑year  smoothing  applied

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Asset  Smoothing  Method

Ã Ten  (10)  Year  Smoothing  with  a  15%  “soft”  corridor u Asset  Gains  and  Losses

•  10%  (1/10th)  will  be  recognized  in  the  Actuarial  Value  of  Assets  each  year

•  The  remaining  90%  (9/10ths)  will  be  a  deferred  asset  gain  (or  loss)  to  be  used  to  offset  future  adverse  investment  returns

u 15%  Corridor •  Actuarial  Value  of  Assets  must  be  no  greater  than  115%  of  Market  Value  and  no  less  than  85%  of  Market  Value

u “Soft”  Corridor •  Once  outside  the  corridor,  the  three  (3)  year  average  of  gains/losses  are  recognized

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Amortization  Policy Ã The  length  of  time  and  the  structure  selected  for  increasing  or  decreasing  contributions  to  systematically  eliminate  any  Unfunded  Actuarial  Accrued  Liability  or  surplus

Ã The  TMRS  Act  allows  for  open  or  closed  amortization  periods  up  to  a  maximum  of  25  years u It  also  allows  the  TMRS  Board  of  Trustees  to  extend  amortization  periods  up  to  30  years  for  cities  who  experience  an  increase  in  contribution  rates  greater  than  0.5%  as  a  result  of  actuarial  changes

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The  Actuarial  Experience  Investigation  Study

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Purpose  of  Experience  Study

Ã An  Experience  Study  is  a  review  of  the  assumptions  and  methods  used  by  the  actuary u TMRS  has  one  prepared  every  four  years u Five-­‐‑year  interval  considered  reasonable

•  GFOA  recommends  at  least  once  every  five  years Ã This  report  tries  to  answer  these  questions  for  each  assumption u What  was  the  TMRS’  actual  experience? u How  does  that  compare  with  current  assumptions? u  Is  a  change  warranted?

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Purpose  of  Experience  Study

Ã Assumptions  are  not  static;  they  should  be  updated  to  reflect u Current  economic  conditions  and  member  behavior  in  the  forward-­‐‑looking  estimates

u Changing  pakerns  of  retirements,  terminations,  salary  increases,  etc.

u Changes  in  benefits  that  might  impact  assumptions u Mortality  improvement  over  time

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Purpose  of  Experience  Study Ã Recent  experience  provides  strong  guidance  for  some  assumptions  (for  example,  mortality)  and  weak  guidance  for  others  (for  example,  the  investment  return  rate)

Ã Some  experience  changes  are  permanent,  while  others  are  cyclical

Ã Based  on  results  of  study: u Actuary  recommends  revised  assumptions  to  the  TMRS  Board  of  Trustees •  Best  estimate  standard  for  each  assumption

u Board  considers  actuary’s  recommendation  and  makes  the  final  decision  for  the  System

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Purpose  of  Experience  Study

Ã The  assumption  set  selected  should  be  reasonable  overall u No  single  “correct”  answer u Small  differences  in  assumptions  can  make  large  differences  in  results

Ã Keeping  assumptions  up-­‐‑to-­‐‑date  will  minimize  gains  and  losses  and  stabilize  the  funding  periods  and  contribution  rates  for  TMRS  cities

 

The  Connection  Between  Actuarial  Science  and  Investment  Planning  in  

Public  Pension  Plans

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The  Investment  Return  Assumption

Ã The  actual  asset  allocation  of  the  trust  fund  will  significantly  impact  the  overall  performance u So  returns  under  a  different  allocation  are  not  meaningful

Ã The  way  this  selection  process  is  supposed  to  work: u How  you  are  invested  drives  the  long-­‐‑term  expected  rate  of  return

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The  Investment  Return  Assumption

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The  Investment  Return  Assumption

Ã Governed  by  Actuarial  Standards  of  Practice  (ASOP)  No.  27,  Selection  of  Economic  Assumptions  for  Measuring  Pension  Obligations,  provides  guidance  to  actuaries  regarding  the  selection  of  economic  assumptions  for  measuring  obligations  for  pension  plans u Was  revised  and  adopted  by  the  Actuarial  Standards  Board  in  September  2013

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Reasonable  Assumption,  per  ASOP  27

Ã An  assumption  is  reasonable  if u  It  is  appropriate  for  the  purpose  of  the  measurement u  It  reflects  the  actuary’s  professional  judgement u  It  takes  into  account  historical  and  current  economic  data  that  is  relevant  as  of  the  measurement  date

u  It  reflects  the  actuary’s  estimate  of  future  experience u  It  has  no  significant  bias  (i.e.,  it  is  not  significantly  optimistic  or  pessimistic) •  Although  some  allowance  for  adverse  experience  may  be  appropriate

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The  Investment  Return  Assumption

Ã We  use  a  “building  block”  approach u Long  Term  annual  Investment  Return  Rate                      =  Inflation  Rate  +  Annual  Real  Rate  of  Return

Ã TMRS’  long-­‐‑term  rate  of  return  assumption  was  7.00% u 3.00%  Inflation  +  4.00%  Real  Return

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Recent  Market  Value  Returns  for  TMRS

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Market 10.6% 0.8% 7.8% -1.3% 10.0% 9.0% 2.3% 9.9% 9.6% 5.7%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

7.00% assumption

6.36% actual

 

6.36%  average  compound  return  (on  market  value)  over  the  last  10  years  

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Inflation Ã By  “inflation,”  we  mean  price  inflation,  as  measured  by  annual  increases  in  the  Consumer  Price  Index  (CPI)

Ã TMRS’  most  recent  inflation  assumption  was  3.00%  per  year

Ã Actual  inflation  (measured  by  the  CPI)  during

u Last  5  years:  1.69% u Last  20  years:  2.28% u Last  30  years:  2.71% u Since  1913:  3.17%  

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Inflation Ã  For  our  analysis,  we  look  at  several  indicators  for  inflation: u  Investment  firms:  2.11%  -­‐‑  2.50%

•  RVK:  2.50% u  Social  Security  Trustee’s  Report:    2.70%  (intermediate,  unchanged  for  

over  10  years) u  Professional  Forecasters:  2.10% u  NASRA/NCTR  Public  Funds  Survey:  3.14%

Ã We  recommended  lowering  this  assumption  to  2.50% u  Closer  to  recent  levels  (2.31%  over  last  10  years) u  Closer  to  levels  expected  in  the  bond  market u  Closer  to  investment  consultants  and  professional  forecaster  estimates

Ã  Inflation  has  been  lower  than  expected;  therefore,  future  overall  return  expectations  have  been  coming  down  as  well

The  Investment  Return  Assumption Ã  Because  GRS  is  a  benefits  consulting  firm  and  does  not  

develop  or  maintain  its  capital  market  assumptions,  we  utilized  the  forward-­‐‑looking  return  expectations  developed  by  the  following  investment  consulting  firms: q  RVK q  Hewik  EnnisKnupp q  JP  Morgan q  New  England  Pension  Consultants  (NEPC) q  Mercer  Consulting q  Pension  Consulting  Alliance  (PCA) q  BNY  Mellon q  Towers  Watson

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Real  Return  Expectations Ã  To  analyze  the  expected  real  return,  we  combine:

u  The  plan’s  target  asset  allocation  with u  Economic  capital  market  expectations

Ã We  examine  the  most  recent  capital  market  return  assumptions  developed  by  eight  investment  consulting  firms u  Placing  emphasis  on  information  from  RVK u Mostly  5-­‐‑10  year  time  horizons

Ã  Then,  we  will  adjust  the  results  for  a  difference  in  time  horizon u Duration  of  the  Plan  liabilities  is  over  20  years

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Puking  it  Together

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(1) (2) (3) (4) (5) (6) (7) (8) (9)

1 5.86% 2.12% 3.74% 2.50% 6.24% 0.07% 6.17% 10.80%

2 6.56% 2.50% 4.06% 2.50% 6.56% 0.07% 6.49% 9.90%

3 6.70% 2.50% 4.20% 2.50% 6.70% 0.07% 6.63% 11.90%

4 6.35% 2.11% 4.24% 2.50% 6.74% 0.07% 6.67% 10.50%

5 6.46% 2.20% 4.26% 2.50% 6.76% 0.07% 6.69% 10.40%

6 6.55% 2.25% 4.30% 2.50% 6.80% 0.07% 6.73% 11.40%

7 6.98% 2.26% 4.72% 2.50% 7.22% 0.07% 7.15% 9.40%

8 7.66% 2.20% 5.46% 2.50% 7.96% 0.07% 7.89% 10.90%

Average 6.64% 2.27% 4.37% 2.50% 6.87% 0.07% 6.80% 10.65%

Standard Deviation

of Expected Return (1-Year)

Expected Nominal

Return Net of Expenses

(6)-(7)Investment Consultant

Investment Consultant

Expected Nominal Return

Investment Consultant

Inflation Assumption

Expected Real Return

(2)–(3)

Actuary Inflation

Assumption

Plan Incurred Expense

Assumption

Expected Nominal Return (4)+(5)

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Recommendation Ã Based  upon  our  analysis,  GRS  recommended  lowering  the  annual  investment  return  assumption  to  6.75% u 2.50%  Annual  Inflation  Rate                                          + u 4.25%  Annual  Real  Rate  of  Return

Ã  In  July,  the  TMRS  Board  of  Trustees  approved  an  annual  assumption  of  6.75%

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Questions?